Cablegate: Indonesia's Financial Sector Policy Package

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DE RUEHJA #0359/01 2280852
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R 160852Z AUG 06
FM AMEMBASSY JAKARTA
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TAGS: EFIN EINV ECON PGOV PREL ID
SUBJECT: INDONESIA'S FINANCIAL SECTOR POLICY PACKAGE

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losses of 70 percent last year over non-transparent pricing
and risk, the package also calls for information
transparency for banking products and other consumer
protection measures. These include a standardized system
for consumers to file complaints and the establishment of an
independent dispute mediation body.

9. (SBU) Although Bank Mandiri and BNI lobbied BI to be
allowed to establish special purpose vehicles that would
take NPLs off their books, the policy actions will instead
amend the rules governing NPLs. They will allow state-owned
banks to work around state laws that have thus far prevented
them from resolving bad loans using techniques commonly
employed by commercial banks. Existing laws, such as the
2003 State Finance Law, treat state-owned banks assets as
"state" assets. As a result, state-owned banks taking a
haircut (loss) on non-performing debt or reselling it at a
discount could be accused of causing a financial loss to the
state, currently considered a criminal corruption offense.
An international advisor at the Finance Ministry tells us
that Bank Mandiri has been waiting for President Yudhoyono
to sign the government regulation allowing state-owned banks
to take haircuts on debt, which has been on his desk since
the end of July.

10. (SBU) Getting rid of the NPLs is only half the battle,
however. Resident expatriate economists note that because
an excess of NPLs reflects a bank governance problem, bank
management must be improved to prevent them from
accumulating anew. Besides allowing the state-owned banks
to resolve NPLs using techniques employed by commercial
banks, the Package also urges they emulate the more
professional management practices of their private sector
counterparts. The package calls for the State Ministry of
SOEs to "ensure the commitment of state-owned banks'
management to corrective measures in governance and risk
management and to efforts for resolving problem loans." The
medium specified for achieving this is the signing of
management contracts on these subjects with the boards of
directors of state-owned banks, a pretty weak mechanism for
producing results.

11. (SBU) The Finance Ministry advisor characterized Bank
Mandiri as "very cooperative" in reform efforts. A senior
contact at Mandiri also pointed out that the bank's new
president, Agus Martowardoyo, had replaced all the group
heads at the bank, which took months. In contrast, BNI is
not replacing key staff, suspended an audit that was
undertaken 18 months ago, and has a disengaged board of
commissioners. The IMF notes that BNI is bloated in terms
of personnel, at two-thirds the size of Mandiri, and unlike
the latter is still non-transparent about its NPLs.

12. (SBU) An international banking consultant told us that
it is not only the old legacy loans that are problematic,
such as the Mandiri loans that have been the subject of
headlines in the past year. New loans are going bad at a
worrisome tempo because banks do not have proper risk
assessment procedures. The consultant lamented that at
least a third of Mandiri's employees are corrupt,
incompetent, or both, and estimated that some 40-50 percent
of new SME loans are going bad because Mandiri still does
not have good risk managers or account officers.

13. (SBU) Though the Financial Sector Package aims to
improve the banks, some debtors still have an attitude
inherited from the New Order, when one of the perks of crony
capitalism was that it was understood that state-owned bank
loans did not always need to be repaid. Our senior contact
at Bank Mandiri told us in confidence that after Bank
Mandiri tried a "name and shame" strategy earlier this year,
publishing the names of problem-loan holders, some debtors
had started to pay, some were paying only interest, and some
who could pay have a bad attitude and are refusing to.
Mandiri's actions provoked a backlash from some companies
that reached out to Palace contacts in an attempt to get the
President to intercede, which he declined to do on advice of
Finance Minister Mulyani. We heard a similar story about
debtors with bad attitudes from the Finance Ministry

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advisor, who told us that Mandiri had "quite legally" seized
a few cash deposits that were used as collateral on
nonperforming loans. In one instance, the customer
complained to the police, who hauled in several dozen
Mandiri staff members including a director for questioning
until 4 a.m. The advisor noted that in the past, Mandiri
would have just made the problem go away by paying the
police more than the client had, but now Mandiri's approach
is to work things out through proper channels.

Bank Consolidation
------------------

14. (SBU) The Financial Sector package includes an item
designed to encourage the consolidation of Indonesia's 131
banks required under BI's Indonesian Banking Architecture
vision. The matrix calls for Bank Indonesia to provide
"incentive" for banks to merge over the next two years, but
does not explain what the incentive will be. BI has had
trouble energizing its bank consolidation program, since the
owners of small private banks like being bank proprietors,
do not want to sell or close their banks, and are unlikely
to respond to rational incentives. The large state-owned
banks, however, have shown sustained interest over the past
year or so in merging with each other, raising the
undesirable prospect of too much banking sector
concentration in precisely the segment that is most poorly
managed. BI has rebuffed these proposals. However, BI's
recently announced "single presence" policy, if it goes
ahead, would bar investors from holding a majority ownership
stake in more than one bank. Designed to encourage
consolidation (and possibly to mollify nationalists piqued
at foreign investment in Indonesian banking), it is unclear
whether the policy would apply to the government, which
holds controlling stakes in the country's three largest
lenders measured by assets-Mandiri, BNI, and Bank Rakyat
Indonesia (BRI).

Next Up, Insurance Sector
-------------------------

15. (U) The third section of the package deals with non-bank
financial institutions, with a marked focus on the insurance
industry. (Note: Indonesia's insurance sector is in bad
health and poorly regulated. Some domestic insurance
companies were merely appendages of conglomerates. End
Note.) The matrix calls for improved implementation of
"Know-Your-Customer" principles across the non-bank sector;
general moves to strengthen the pension fund sector,
including drafting a development road map for the industry
and good governance guidelines; and MOF decrees on
strengthening the capital structure, regulation and
supervision of finance companies and venture capital firms.
Both insurance pension industries are underdeveloped in
Indonesia, depriving the nation of good sources of long-term
capital that could be invested in infrastructure. The
insurance industry is small, according to the World Bank in
January 2005, with assets equal to just 5 percent of GDP and
6 percent of total financial sector assets. The industry is
also highly concentrated, with the ten largest insurance
firms dominating three-quarters of the sector. The pension
sector is similarly small, commanding only about 3 percent
of financial system assets.

16. (SBU) Indonesia's insurance industry has made progress
since international insurers Manulife (in 2002) and
Prudential (in 2004), were declared "bankrupt" by the
Indonesian court system on spurious grounds. Now the GOI is
wrestling with genuinely bankrupt insurance firms, in
particular, Bumiputra 1912, Indonesia's preeminent domestic
insurance company. Bumiputra 1912 is "totally bankrupt,"
according to our insurance industry contacts, with premiums
collected today being paid out tomorrow in claims. It
should theoretically be shut down, but since it insures
teachers and similar professions in the lower-to-middle
class, the GOI is concerned about disruptive social
consequences if the firm were allowed to fail. Upon
discovering that Bumiputra 1912 is incorporated as
Indonesia's only mutual life insurance company, the GOI made

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